Editorial: Blocking a blow to small business

2013-05-21 16:57:38

Sen. Ted Lieu, a Torrance Democrat, frankly, seems to us the rather unlikely sponsor of legislation that aims to spare California businesses from $120 million in retroactive state taxes, no matter how unfair the assessments.

So count us pleasantly surprised that the lawmaker is carrying Senate Bill 209, which would reenact a recently struck-down income tax deferral for capital gains when selling qualified small-business stock.

The issue came to the fore this past August when a state appeals court in Los Angeles unanimously declared that a 1993 California law, intended to encourage investment in start-ups and other small businesses within the state, interfered with interstate commerce.

The ruling came in a case brought by Frank Cutler, a Newport Beach investor, who was an early backer and board member of US Web, a Silicon Valley start-up that went public in 1997. In 1998, Mr. Cutler sold some of his shares for $2.3 million and, in turn, invested some of the proceeds in three other small businesses.

On his 1998 state income tax return, Mr. Cutler deferred the portion of his $2.3 million gain invested in the three small businesses, as he thought, understandably so, the 1993 law allowed. In 2004, the Franchise Tax Board decided to review the Newport Beach investor's 1998 return.

It declared that US Web was not a "qualified small business" because it did not maintain at least 80 percent of its assets and 80 percent of its payroll in California. It disallowed Mr. Cutler's tax deferral and sent him a bill for $200,000 in unpaid taxes and $47,600 in penalties.

The state appeals court ruled against the FTB, holding that the requirements of the state law ran afoul of the U.S. Constitution's commerce clause.

Instead of complying with the court ruling – which would have allowed the state to retain the requirement that "at issuance," a stock be in a small business that has 80 percent of its compensation paid in California, the FTB decided instead to completely disallow investors from claiming deferrals and exclusions under the 1993 law.

Worst still, it made its decision retroactive to 1998, making investors liable for back taxes and penalties.

Sen. Lieu's legislation would reverse the FTB's decision, amending the 1993 law to reflect the decision of the state appellate court, while setting aside the $120 million in retroactive taxes the FTB would impose upon investors who claimed deferrals or exclusions on their tax returns.

"SB209 is about the rule of law," he said. "You simply cannot punish people for following what we told them to do."

Mr. Lieu's measure is slated for a May 23 hearing before the Senate Appropriations Committee. It deserves bipartisan support.